The Internal Revenue Service (IRS) determined last week that virtual currency, such as bitcoin, is not currency at all. This may be the end of the expanded use of bitcoin in everyday regular transactions because by just using bitcoin at tangible real-world merchants to buy real things may expose you to additional taxes, and it is likely more of a headache than it’s worth.
The progression of the internet and the online nature of commerce have led to the use of virtual currency with bitcoin being the most popular. Such use of convertible virtual currency has not gone unnoticed by the IRS which recently provided an official stance on the taxable nature of such virtual currency that will likely be case fodder for the next generation of tax attorneys.
A little background may be necessary: convertible virtual currency, such as bitcoin, is a product of the internet. It’s not real in the sense that you can’t hold it or put in in a safe deposit box. However, it is real in the sense that you can use it to purchase or sell tangible items online or even at real, non-online storefront merchants. Apparently, some people even get paid using bitcoin.
According to the IRS, virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency -- i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance -- but it does not have legal tender status in any jurisdiction.
The key to the IRS’ determination and what makes this non-tangible thing that you can never hold, taxable and subject to IRS collection assessments is whether the virtual currency is “convertible” into the real world.
Virtual currency is convertible if it has an equivalent value in real currency or if it acts as a substitute for real currency. Bitcoin is one example of a convertible virtual currency and according to the IRS is taxable because it can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies.
It presently appears that the IRS will tax bitcoin and other convertible virtual currency transactions as it already taxes non-currency property transactions, such as stocks and other bartering transactions. Therefore, a person who receives virtual currency as payment for goods or services must include the fair market value of the virtual currency when computing their taxable gross income. The taxable amount is to be measured by the value of the virtual currency in U.S. dollars as of the day the virtual currency was received, and its present value when it is spent.
This makes legitimate use virtual currency more difficult to use than normal currency; or even foreign currency, which was an alternative path the IRS may have taken when determining tax treatment of virtual currency.
In typical IRS fashion, although this guidance was just made official, failure to abide by the guidance before it was even issued may expose you to tax assessments, penalties, and interest. Therefore, if you have used virtual currency in the past, it is time to consider amending your tax returns; and if you owe a real tax debt, the IRS accepts real cash.
This article is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.